Analyst Scott Power Finds the Upside in Biotech Down Under

Source: George S. Mack of The Life Sciences Report (11/8/12)

If you're looking for fresh international names in biotech and medtech, but need the comforts of end markets on U.S. soil, the best ideas of RBS Morgans Ltd. Senior Analyst Scott Power might be for you. In this interview with The Life Sciences Report, Australia-based Power makes a case for important life science names with Australian origins and a U.S. presence that could present investors with huge upside.

The Life Sciences Report: Scott, do you get a fair amount of attention from institutional investors in North America and Europe? Where are the most interested investors outside of Australia?

Scott Power: Most of our investment interest presently comes out of Australia, New Zealand and, to a smaller extent, Asia. We don't get a huge amount of interest in the Australian life science sector from either Europe or the U.S. That's been the case over the last couple of years, and is probably a function of the high Australian dollar. If we rewind five or six years, there was quite a bit of interest out of the U.S.

My contention is that a number of good-quality life science companies either have products in market or are about to have products approved that are very much U.S.-focused, and will increasingly attract attention from U.S. investors. The timing of our conversation today is excellent because some very good opportunities are emerging in Australia. The sophistication of the Australian Stock Exchange makes investing quite straightforward for overseas investors.

TLSR: So you believe the current problem is that European and U.S. investors think Australian stocks are expensive because of the currency differential?

SP: Yes.

TLSR: Excepting the currency issues, what are the salient differences between small or emerging life science companies in your coverage versus those in North America and Europe?

SP: We in Australia tend to be more single product-focused. The pipelines are not what you'd call broad. That is one difference. Management teams probably aren't as strong as what American and European investors are used to either, and the shareholder base is more retail-focused, meaning quite a few Australian companies have large holdings in the hands of mom-and-dad investors.

TLSR: Generally speaking, does Australia's physical distance from North America or Europe in any way hinder drug development, partnership deals or merger and acquisition activity? Are these companies isolated in some way?

SP: Because we are quite distanced from the rest of the world, some of our more mature companies are virtually migrating their businesses to the U.S. and/or Europe to bridge the gap. Does that make it difficult to do licensing deals? It certainly means that management teams must spend a lot of time on airplanes and outside of Australia.

TLSR: Can we talk about some of your ideas? What is your favorite company?

SP: I have a couple of favorites, but the one most visible to U.S. investors at the moment is Acrux Ltd. (ACR:ASX). It has the largest market cap in Australia's life science sector outside Mesoblast Limited (MBLTY:OTCPK). Acrux has developed an across-the-skin delivery technology for its product Axiron (testosterone), to treat males with medically low levels of testosterone. Axiron is a new addition to the low testosterone market. Abbott Laboratories (ABT:NYSE) has the lion's share of that market, with its AndroGel (testosterone gel) product. The difference between the two products is that Axiron is delivered to the armpit of a male, whereas AndroGel is applied to the upper torso. Axiron is a much easier application.

"Some very good opportunities are emerging in Australia."

Axiron was launched about 15 months ago by Eli Lilly and Co. (LLY:NYSE), its marketing partner, and it has had very good take-up to date. The company hopes to increase its market share from about 13% currently, in what is calculated to be a $2 billion market. Axiron is growing at 30% per year now.

This is a profitable business, and Lilly pays a royalty on sales, which Acrux will distribute to its shareholders. The bulk of shareholders are Australian institutions, but increasingly there are a number of Asian investors coming into the stock, and it's one that U.S. investors can identify with and will be able to follow easily.

TLSR: You noted in a research report that Abbott had begun to rebate heavily to keep Axiron from carving out market share. How much difference will this make for Acrux in the end?

SP: The rebating and discounting have been quite intense. They have caused us to delay our numbers, pushing back about 12 months from where we thought the business would be. But the rebating has started to soften, and Lilly has Axiron on the formularies of a number of insurance companies. A fairly intensive advertising campaign is kicking off in the U.S., and we expect market share to grow quite strongly on a monthly basis from the current 13%.

TLSR: The stock is down about 20% over the past six months. Do you consider this a value stock at this point?

SP: Yes. The recent quarterly result was a little disappointing in that it showed a minor pullback in growth on a quarterly basis. Lilly was reporting the quarterly numbers. We expect a strong Q4/12. We are telling investors that the share price weakness is a good buying opportunity. Our valuation on the stock is around AU$3.70.

TLSR: Would you be reevaluating that target if Q4/12 numbers come in as strongly as you expect?

SP: No, because that's what we are expecting. However, Acrux currently has an application in the U.S. Patent and Trademark Office (PTO) to extend its core patent, the application of testosterone to the armpit of a male, from 2017 to 2026. That application has been with the PTO for a considerable period of time, and additional information is being provided. An answer is expected in Q1/13. If that patent extension comes through, we'd look to add another AU$0.40–0.50 to our AU$3.70 valuation.

TLSR: It obviously hurt when Paradice Investment Management ceased being a substantial shareholder in Acrux back in late August. Did that have a cascading effect?

SP: Two institutional shareholders sold out. One was Paradice, and the other was AMP Ltd. (AMP:ASX). Those were substantial, but they were replaced by Fidelity Investment Management and another strong Australian company, Ellerston Capital, which has the backing of the Packer family, one of Australia's wealthiest families.

TLSR: Can you share another interesting story?

SP:Alchemia Limited (ASX:ACL) is very interesting and, again, will be coming onto the radar screens of U.S. investors soon. It has a two-part business. One is a generic version of the GlaxoSmithKline (GSK:NYSE) blood-thinning product called Arixtra (fondaparinux). Alchemia's fondaparinux was launched about 12 months ago in the U.S., where it is marketed by Dr. Reddy's Laboratories Ltd. (RDY:NYSE). Presently it has just under a 40% market share in the pharmacy channel, and it is building its hospital market.

The other part of Alchemia's business is a cancer program, which uses hyaluronic acid (HA) and existing cancer drugs. It now has a phase 3 trial in metastatic colorectal cancer (mCRC) testing HA-irinotecan. It is halfway through patient recruitment, which should be finished by the end of 2012 or early 2013. Results are due out Q3/13, and that will be a significant value inflection point for the company. What's interesting is that this company is demerging, so the two businesses will be separated. There will be an IPO for the cancer unit on NASDAQ, which should raise between $40–50 million ($40–50M). That should take place in the next few weeks.

TLSR: This company has an AU$152–153M market cap. Is one of the new companies going to keep the name Alchemia?

SP: The generic blood-thinning product business will keep the name Alchemia. The cancer company will be called Audeo Oncology Inc. A Securities and Exchange Commission Form S-1 will be prepared, and U.S. investors will come in together with Australian and some Asian investors.

TLSR: So far, how much more efficacious has HA-irinotecan been than irinotecan (original brand name Camptosar, marketed by Pfizer Inc. [PFE:NYSE]) alone?

SP: The phase 2 results, which have been published, have shown that in 76 patients with mCRC, HA-irinotecan was able to double progression-free survival to 5.2 months, versus 2.4 months for irinotecan alone.

TLSR: Do you anticipate a lot of U.S. investor interest?

SP: Yes. The company will be based in San Francisco and its board is primarily U.S.-based. The Australian management team will transition to a U.S. management team over the next 12 months.

TLSR: Another idea?

SP:QRxPharma Ltd. (QRX:ASX) has a pain product that combines oxycodone and morphine. It's been through a series of clinical trials. It was knocked back at a new drug application (NDA) meeting in July this year when the U.S. Food and Drug Administration (FDA) issued a complete response letter for additional information. The company is reworking some of the data that it provided to the FDA. We are looking for a new approval date in mid-2013.

TLSR: What is the market for this product? Oncology?

SP: No, the market is postsurgical acute pain—bunionectomies, hip and knee replacements. Assuming it gets approval next year, the drug will be distributed in the U.S. Its marketing partner is Actavis Inc., which has been taken over by Watson Pharmaceuticals Inc. (WPI:NYSE). Watson will distribute the product in the U.S.

TLSR: Do you have another name for investors?

SP:ImpediMed Ltd. (ASX:IPD) has a bioimpedance spectroscopy (BIS) device that detects lymphedema in postsurgical breast cancer patients at a very early stage. The product, called the L-Dex U400, currently is being used in the U.S. It has Current Procedural Terminology (CPT) category 3 coding (emerging technology), and it is being rolled out in a number of surgical oncology offices. It's a 10-minute test, done 3–4 times per year after breast cancer surgery. With the early detection or subclinical detection of lymphedema, treatment can prevent its onset.

"Because Australia is quite distanced from the rest of the world, some of our more mature companies are virtually migrating their businesses to the U.S. and/or Europe."

U.S.-based CEO Richard Carreon was appointed in July 2012, and the business is based in San Diego. The company is very accessible to investors. The interesting story here is that the share price has absolutely cratered, and the company now has a market cap of less than AU$30M. The primary reason for the plunge is that the company has been unable to secure insurance coverage from a number of the larger insurers. It has a lot of clinical evidence, but getting signoffs from the larger insurers is proving difficult and is taking a lot of time. Some investors have gotten very bored and have punished the stock. However, Carreon is taking a more regional approach, is talking with a number of smaller insurers and is building up coverage. ImpediMed is an interesting turnaround story.

TLSR: At the end of August you reduced your target price from AU$1.01 to AU$0.65. But your implied upside is a fourbagger from current levels. Do insurers consider this product to be gimmicky?

SP: No. I think they are looking for more data—and data relevant to their client bases. The product has recently been implemented by Kaiser Permanente as one of its prevention initiatives.

TLSR: What is the value proposition? Is the device able to tell the oncologist that the patient has lymphedema before she even has symptoms?

SP: Yes. It measures the intracellular fluid levels and picks up changes at a very early stage.

TLSR: You see this as a deep value play, correct?

SP: Yes. Essentially, people have not thought that this business model would work, but I'm confident the product is technically and commercially significant.

TLSR: Scott, are other companies using bioimpedance spectroscopy for indications like lymphadenopathy?

SP: It is very limited. The only other devices are much larger, research-based and really don't have any application in the clinical world.

TLSR: Can you mention other interesting companies, either U.S.- or Australia-based?

SP:Sunshine Heart Inc. (SSH:NASDAQ) is also U.S.-based. It is dual-listed, so it can be bought and sold quite comfortably in the U.S. It's run by Dr. Dave Rosa, a very impressive guy living in Minnesota. The product is the C-Pulse heart assist system, which treats heart failure. Moreover, it is aimed at class III heart failure, whereas Thoratec Corporation (THOR:NASDAQ) and HeartWare Int. (HTWR:NASDAQ) have implantable devices aimed at class IV heart failure. The C-Pulse is less invasive, and it has no contact with the blood. It's basically a cuff system that sits around the ascending aorta. An external pumping mechanism squeezes a balloon mechanism, which pushes extra blood into the heart. It has recently completed a feasibility trial and is about to start a 350-patient pivotal study in the U.S. An obvious buyer of this business would be Thoratec, HeartWare or some other large company looking to expand its device pipeline into later-stage heart failure.

TLSR: I am, indeed. It is a treatment for acute influenza virus infection.

SP: Biota has a smaller, but competitive, inhalable product called Relenza (zanamivir), a neuraminidase (NA) inhibitor, which has been licensed to GSK. It now has a long-acting NA inhibitor, Inavir (laninamivir octanoate) that has been approved in Japan as a once-only treatment. It is marketed in Japan by Daiichi Sankyo Co. (DSKYL:OTCPK) and is a next-generation product. An NDA is planned for laninamivir in the U.S., and since the U.S. government is funding it, the company felt it was best to locate itself in the U.S. As of Nov. 8, 2012, Biota Pharmaceuticals Inc. will relist on NASDAQ with approximately $70M in cash, royalties from Relenza and Inavir, and a pipeline of earlier-stage programs focused on infectious diseases.

TLSR: Do you have another interesting story?

SP:Pharmaxis Ltd. (PXS:ASX) has a treatment for cystic fibrosis (CF) and bulk bronchiectasis. Called Bronchitol, this inhaled, powdered, mannitol-based product reduces mucus buildup in the lungs. The market leader at the moment is Pulmozyme (dornase alfa, marketed by Genetech/Roche Holding AG [RHHBY:OTCQX]). In June Bronchitol was launched in Germany, and it recently received National Institute for Health and Clinical Excellence approval for reimbursement of the product in the United Kingdom. So far it has done very well. It has an NDA pending in the U.S., with a Prescription Drug User Fee Act (PDUFA) date of March 18, 2013. If you look at the share price chart, you'll see that it had a very steep fall about 12 months ago. The product got knocked back in the European Union, but after a lot of negotiation, it has received a narrower claim for patients 18 years and older. The regulators thought the evidence wasn't compelling enough for its use in children.

TLSR: You noted in a research report that 83% of CF centers in Germany have been trained to administer the initiation dose of Bronchitol, and 40% of the centers had completed an initiation test on at least one of their patients. That is amazing uptake.

SP: Yes, it is very strong uptake. But Germany is a small market, and CF is a small disease. We will monitor its progress on a quarterly basis. Pharmaxis probably has the broadest U.S. investor base among Australian life science companies.

TLSR: Do you have one more company you can talk about?

SP: Yes. The final story worth bringing to your attention is Genetic Technologies Ltd. (GENE:NASDAQ; ASX:GTG). Again, it's an Australian business; the company produces the BREVAGen test for determining a woman's risk for getting non-familial breast cancer. It acquired this U.S. technology from a U.S. company that was struggling, so it didn't pay too much for it. Now Genetic Technologies has set about building a sales force and rolling the product out. It is still in its early days; I think this test is available in all states except for New York.

The interesting thing is the ease of the testing. A cheek swab is taken and sent for testing at the company's Melbourne facility. The results are returned the next day. The facility in Melbourne has Clinical Laboratory Improvement Amendments accreditation, which is very difficult to get, and there are very few of such facilities in the Southern Hemisphere.

TLSR: Obviously BREVAGen is the value driver, but the company's products are really all over the place. It has everything from paternity testing to forensics to the BREVAGen test. It has an AU$51M market cap. Can it keep its focus and develop its sales force?

SP: Fair question. If you break it down into its separate components, it has intellectual property (IP) around junk (non-coding) DNA, for which it is signing up licenses when people infringe. It is setting about getting some recompense for that.

TLSR: Are these cash settlements, or is Genetic Technologies making deals with the companies that infringe on its IP?

SP: Both. The total adds up to AU$9M/year.

TLSR: Thank you, Scott. I've enjoyed it.

SP: Great. Well, thanks for your time as well.

Scott Power has spent the last 20 years investing in and researching emerging companies. His first role in the venture capital industry was with QIDC. He joined RBS Morgans Ltd. in 1997. Power sees Australia as a country that produces world-class technology, particularly in the life science sector. Companies like Cochlear Ltd., CSL Ltd. and ResMed have established themselves as market leaders, and a number of up-and-coming companies across the healthcare, life science and technology sectors are poised to follow the leaders, potentially generating significant profits. Power has a wide network of contacts across these sectors that help him identify key trends and developments. Power holds a bachelor's degree in commerce from the University of Queensland and a graduate diploma in applied finance from FINSIA. He is a certified practicing accountant (CPA).

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DISCLOSURE: 1) George S. Mack of The Life Sciences Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.2) The following companies mentioned in the interview are sponsors of The Life Sciences Report: Genetic Technologies Ltd. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.3) Scott Power: I personally and/or my family own shares of the following companies mentioned in this interview: Acrux Ltd., Alchemia Ltd., QRxPharma Ltd., Sunshine Heart Inc., Biota Holdings Inc. and ImpediMed Ltd. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.4) RBS Morgans Corporate Limited was the Lead Manager to the Alchemia Limited share placement and SPP in November 2011 and received fees in this regard. RBS Morgans Corporate Limited was Lead Manager to the Sunshine Heart Inc. share placement in August 2011 and received fees in this regard. RBS Morgans Corporate Limited was a Joint Lead Manager to the QRxPharma Limited placement and rights issue in July 2011 and received fees in this regard. RBS Morgans Corporate Limited was a lead manager to the ImpediMed Limited accelerated non-renounceable entitlement offer in May 2012 and received fees in this regard. RBS Morgans Corporate Limited was a participating broker to the Pharmaxis Limited rights issue in November 2011 and received fees in this regard.

Other Mentioned Companies

Abbott Laboratories

Acrux Ltd.

Alchemia

Biota Pharmaceuticals Inc.

Eli Lilly and Co.

GlaxoSmithKline

HeartWare Inc.

Pharmaxis Ltd.

QRxPharma Ltd.

Sunshine Heart Inc.

Thoratec Corp.

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